A reference to the underground economy—also known as the shadow or
black economy—may conjure up images of people paying someone to conduct an illegal activity, but the term actually has a far broader scope.It also refers to any income-generating endeavor that is not reported to government authorities and, consequently, is not taxed.
Key Takeaways
– The underground economy includes any paid work or transaction that is not reported to the government and, therefore, is not taxed.
– Less developed countries tend to have more underground economic activity than more developed nations.
– Countries with high levels of taxation, government corruption, and regulatory barriers tend to have the largest underground economies.
How Big Is the Underground Economy?
Estimates vary widely, but some put the underground economy between 6.4% and 12% of U.S.
gross domestic product (GDP).In the second quarter of 2023, U.S.GDP was estimated at $27.06 trillion, which puts the underground economy somewhere between $1.7 trillion and $3.2 trillion.
Economist Friedrich Schneider estimated that the size of the U.S.underground economy, excluding criminal activity like drug dealing, was 7.2% of gross domestic product (GDP) in 2007.
That put the U.S.well below the global average for that year of 13.9% of GDP, according to the Organisation for Economic Cooperation and Development.In another estimate, economist Edgar Feige estimated that underground economic activity in the U.S.
in 2009 totaled $2 trillion, approximately 12% of GDP (at that time).
These figures are, of course, estimates.There’s an obvious complication in trying to determine the size of any country’s underground economy.The activities in it are, by definition, not reported, and those engaging in it do their best to remain undetected.
6.4% to 12%
The estimated size of the U.S.underground economy as a percentage of GDP.
Why Is There a Shadow Economy?
Shadow economies are nothing new—in fact, they have likely existed as long as there have been authorities controlling markets, the means of value exchange, and collecting taxes.People want and need products and services they might be unable to afford, find on local markets, or are prevented from purchasing.They may also want to avoid taxes or wish not to have their activities detected or monitored.
So, many people turn to marketplaces that operate anonymously and provide them with a way to earn money or find what they want undetected.
This is especially true in less developed areas, where shadow markets tend to account for more of a percentage of gross domestic product than official economies.For example, in a 2019 study, Leandro Medina and Friedrich Schneider found that in countries like Bolivia, the underground economy averaged 62.9% of GDP.
The reasons that underground economies exist are numerous, but trends indicate that how economically developed an area is dictates how strong (or weak) its shadow economy will be.
Bypassing Requirements
The level of government and local corruption is another factor that can contribute to a larger shadow economy.The abuse of public power for private gain can drive businesses and workers to the underground economy for refuge.
Some smaller private employers might use the shadow economy to make their lives easier.Avoiding the government means circumventing government regulations related to employee benefits, withholding and submitting required taxes, working conditions, and safety regulations, not to mention a great deal of regulatory paperwork.
The Undocumented Factor
People without legal status often find themselves working for cash in the underground economy.
Obviously, their status keeps them from reporting their income, as doing so could result in their deportation.The barriers faced by people seeking nationalization, asylum, or refuge in the U.S.are high.One of the only ways people facing these circumstances can earn money is by working in the shadow economy.
Cons of the Underground Economy
One downside is the loss of government revenues.The IRS estimated that $496 billion—in under-reported, underpaid, and non-filed taxes—in taxes were lost on average between 2014 and 2016 due to unreported wages (the latest available information).
But there are
other reasons to be concerned.Workers in the underground economy are truly under the radar.
They don’t receive health insurance or worker’s compensation benefits; they have less legal protection, making exploiting them easier.Additionally, they are not contributing to social programs funded by tax revenues, like Social Security, the Supplemental Nutrition Assistance Program, or others designed to assist those in need.
Is an Underground Economy Good or Bad?
The answer depends on what the activities are, how they benefit the participants, and how they affect the area’s official economy.An underground economy might be the only way people in one area can get enough food to survive.In contrast, in a more developed economy, the shadow economy might be more beneficial for those in illegal activities.
Does the U.S.Have an Underground Economy?
Yes, the U.S.has a shadow economy.If you have ever worked “under the table” or “off the books” and not reported the income from it, you’ve participated in the shadow economy.
What Is the Problem With Underground Economies?
Underground economies take tax revenues, and thus benefits, from social or other programs that developed economies have in place to assist those in need.They also take capital away from government funds used to keep it running, in addition to other issues.
The Bottom Line
Underground economies are a familiar scene in nearly every country, but they are most prevalent in less- or under-developed areas.
In the U.S., it is estimated that the underground economy averages between 6.4% and 12% of GDP.They can reach more than two-thirds of a country’s GDP in other areas..
